Booz Allen Hamilton Holding Corp (BAH) 2014 Q3 法說會逐字稿

Welcome to Booz Allen Hamilton's earnings call covering third-quarter results for FY14.

(Operator Instructions)

I'd now like to turn the call over to Mr. Curt Riggle. Please, go ahead.

Thank you, Stephanie. Thank you all for joining us today for Booz Allen's third-quarter FY14 earnings announcement. I'm Curt Riggle, Director of Investor Relations. With me to talk about the business and financial results this morning is Ralph Shrader, our Chairman and Chief Executive Officer and Sam Strickland, Executive Vice President and Chief Financial Officer. We hope you've had an opportunity to read the press release on our third-quarter earnings that we issued earlier this morning. We've also provided presentation slides on our website and are now on slide 1.

As shown on the disclaimer on slide 2, please keep in mind that some of the items that we will discuss this morning will include statements that may be considered forward-looking and, therefore, are subject to known and unknown risks and uncertainties, which may cause our actual results in future periods to differ materially from forecasted results.

Those risks and uncertainties include, among other things, general economic conditions, the availability of government funding for our Company services and other factors discussed in today's earnings release and set forth under the forward-looking statements disclaimer included in our FY14 third-quarter earnings release and in our SEC filings. We caution you not to place undue reliance on any forward-looking statements that we may make today and remind you that we assume no obligation to update or revise the information discussed on this call.

During today's call, we will also discuss some non-GAAP financial measures and other metrics which we believe provide useful information for investors. We include an explanation of adjustments and other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our FY14 third-quarter slides. It is now my pleasure to turn over to our CEO, Ralph Shrader. He'll start on slide 3.

Thank you, Curt. Good morning, and thank you all for joining us on this last day of January. We had the privilege to start this month by ringing the opening bell at the New York Stock Exchange. On January 2, we kicked off trading on the big board for 2014 and celebrated the start of Booz Allen Hamilton's 100th anniversary year.

100 years ago, Edwin Booz founded our Firm and started the management consulting profession. The significant contributions Booz Allen has made to business and government over the past 100 years is something we take great pride in.

As investors, I know your interest lies in our future more than our past. I want to assure you that, while we strive always to learn from the past, Booz Allen's management team and our nearly 23,000 employees today are focused on the future. As discussed on our previous earnings calls, we are also investing strongly in the future, in capabilities in markets such as cyber, advanced analytics and engineering, health and predictive intelligence, areas that we believe have future growth potential for us.

Today, we are reporting on results for our third-quarter FY14, ended December 31, 2013. Those results are in line with the expectations we shared on our earnings call last fall. During the first half of FY14, we focused on maximizing productivity of our consulting staff and tightly managing our costs in line with revenue to provide flexibility to respond to a challenging and uncertain market. That fiscal prudence served us well during this current quarter, when the federal government shut down for almost three weeks back in October.

Because Booz Allen's work is focused on our core clients' core missions, essential operations as defined by the government, we were able to keep approximately 90% of our consulting staff performing client work during this shutdown. For the remaining 10%, we were able to cover their compensation and benefits while they engaged in non-billable work.

This approach retained and paid our talented people until our clients reopened for business. I'm very pleased we were able to support our people in this way. But, as expected, it was an impact to our top and bottom line, which you see reflected in our FY14 third-quarter results.

Here are the financial highlights. Third-quarter revenue was $1.27 billion, compared with $1.39 billion in the prior-year period. Adjusted net income was $49.5 million, compared with $59.7 million in the prior-year period.

Adjusted EBITDA decreased 15.3% to $115 million. Adjusted diluted earnings per share decreased by $0.08 to $0.33 per share. Booz Allen's total backlog, as of December 31, 2013, was $10.37 billion, compared with $12.68 billion in the prior-year period. Funded backlog was $2.5 billion, compared with $3.15 billion in the prior-year period.

Booz Allen has always managed our business and made our forecast and earnings commitment on an annual basis. I'm pleased to say that, looking ahead to the end of the current fiscal year, we are narrowing the range for FY14 earnings in line with our previous guidance. Sam will say more about this when he discusses the detailed financial results and drivers of those results.

Given our continued strong cash flow generation, we are declaring a regular dividend of $0.10 per share and a special dividend of $1 per share, both payable on February 28 to stockholders of record as of February 10, 2014. This reflects our ongoing commitment to return value to all of our shareholders.

Taking a page from our Founder, Edwin Booz, who wrote -- Start with character, intelligence and industry when choosing people -- we have chosen his theme, start with character, for our centennial year and have expanded upon that with three statements that underscore our commitment to clients, employees, investors, and community. First, act with integrity. Second, serve with purpose. Third, reach forward.

You can see this commitment to integrity, service, and innovation in everything we do at Booz Allen. During the past quarter, Booz Allen won contracts to perform mission-critical work for our clients across civil, security, and defense markets.

Here are just a few of the significant contracts and task orders we won during the third quarter: a series of contracts with the US Air Force totaling approximately $70 million to support the Secretary of the Air Force, the Air Force Research Laboratory, Air Force Material Command and Air Force Surgeon General with information technology, simulation and analysis, engineering and management services; a contract worth $42.9 million to support the Missile Defense Agency, with strategic planning and financial management services; a series of contracts worth over $13 million from the US Department of Transportation to support aviation, highway and rail transportation improvement programs. We've also been awarded several significant contracts to support commercial clients in the pharmaceutical industry with information security and business intelligence services.

Moving to our commitment to serve beyond office walls, we have announced for calendar year 2014, the Booz Allen Hamilton Centennial Community Challenge to inspire our employees to reach a goal of 100 hours of community service as individuals and of 100,000 hours of community service together across the Firm. With just one month of our centennial year underway, we're already well on our way to this goal.

An event this January which exemplifies Booz Allen's spirit of service was a conference we hosted for women veterans at our McLean, Virginia, headquarters, which I think is best described in the words of Pamela Hardy, a Senior Associate in our recruiting team. Quoting her, "Last week, I was fortunate to attend one of the most inspiring events I've been part of since I joined Booz Allen nine years ago."

More than 100 women veterans of all ranks and at all stages of their careers gathered at our McLean campus for a women veterans conference sponsored by Booz Allen and put on by the Virginia Employment Commission, Business and Professional Women's Foundation, and the Virginia Wounded Warrior Program. More than 30 exhibitors -- representatives of private industry, non-profits, and federal and local government -- also came together, with a shared mission to provide these women veteran with practical skills to help them navigate their careers and opportunities to connect with employees and available resources.

This spring and summer, Booz Allen will give back to the community by sponsoring a major exhibition at the National Gallery of Art of the works of Impressionist masters Edgar Degas and Mary Cassatt. This sponsorship, which showcases the collaboration and innovation of these renowned artists, is a signature event of our centennial celebration. If you are in Washington, DC, between May and October, I hope you will be able to see it.

Sam will now provide you with a closer look at our financial results for the third quarter of FY14 and the underlying drivers of these results.

Thank you, Ralph. Good morning, and thank you for joining us. As Ralph said earlier, this past quarter, we saw revenue declines as a result of the government shutdown and an environment of continuing uncertainty while the government operated under a continuing resolution.

We also saw income declines in the third quarter, as compared to the prior-year period. But as I'll talk about this morning, these bottom-line results were in line with our expectations as we leveraged some of the financial flexibility we generated as a result of our effective cost management in the first half of our fiscal year.

After nine months, we remain on track for full-year results that are consistent with the guidance we provided you last quarter. It seems like I say this every quarter, but I can't emphasize it enough -- the reason we're still on track for the full year, even with the challenges we've experienced in the third quarter, is that we carefully manage our business on an annual basis.

Any given year has an ebb and flow of events and economic conditions that impact our performance from quarter to quarter, and each year is different. But we have developed the skill to manage our business very effectively, so that we account for the variances within the year and the year-end target -- with the year-end target as the ultimate goal.

Before going into greater detail on the first nine months and third quarter of FY14, I want to look back to the prior year, FY13, to illustrate how these ebbs and flows vary by year and the challenges of comparing a single quarter with the prior year's quarter.

In the first half of 2013, we took action to reduce costs. We also continued to refine processes to manage the business more efficiently in light of declining revenues. It wasn't until midyear that we were able to fine-tune the business under these new conditions.

In the second half of our FY13, we emerged as a leaner and better managed Firm. From that point on, we performed well, growing earnings at a stronger pace and came in on target for our annual projections. You can see the results of these improvements in the bottom line results for the third quarter of FY13.

Now in the first half of FY14, we continued that tight management of the business with great success, knowing that the uncertainty was likely to continue into the third quarter. When the government shutdown did occur, we were financially ready for it with the flexibility we created in the first half.

However, when you compare the challenging third quarter of FY14 with the particularly high-performing prior-year quarter, the declines can seem more stark than they would be if you looked at our annual trajectory. I think this is important context as we discuss the year to date and third quarter.

Let's turn to slide 4 for a closer look at our year to date and third quarter of FY14. Year to date, we have seen a decline of 3.2% in our top-line revenue over the prior-year period. In the third quarter, we saw a revenue decrease of 8.6%. The decrease in year-to-date revenue was largely the result of headcount reductions and a corresponding reduction in billable hours due to the uncertainty in the federal budget environment.

Last quarter, I told you that I anticipated the October government shutdown would have a roughly $30-million impact to revenue. In fact, we did see that in the third quarter. Additionally, about half of the decline in the third quarter was due to a $62.2 million decrease in billable expenses. We do not generate significant margins on these pass-through expenses, so the decline in these costs has a limited impact to our overall margin.

In the first nine months of FY14, operating income increased by 11.4%; adjusted operating income increased by 8.1%; net income increased by 12.8%; adjusted net income increased by 6.3%; EBITDA increased by 9.8%; and adjusted EBITDA increased by 8% over the first nine months of our prior fiscal year. The improvement in the year-to-date metrics benefited from the cost management in the first half.

The third-quarter results that I'll now discuss reflect the use of some of the financial flexibility that we created in the first half. And, as I said earlier, put us on the path to deliver a full-year in line with our bottom-line expectations.

In the third quarter of FY14, operating income decreased to $97 million from $116.6 million in the prior-year period, and adjusted operating income decreased to $99.1 million from $120.8 million in the prior-year period. The decrease in operating income and adjusted operating income was primarily driven by the combination of headcount reductions and an increase in unbillable labor as a result of the government shutdown. Additionally, we saw an increase in activities associated with investments in growth areas, which is in line with our announced plan for the year.

In the third quarter of FY14, net income decreased to $47.2 million from $56.2 million in the prior-year period, while adjusted net income decreased to $49.5 million from $59.7 million in the prior-year period. Adjusted EBITDA decreased to $115 million from $135.8 million in the prior-year period.

In the third quarter of FY14, diluted earnings per share decreased to $0.31 per share from $0.38 per share in the prior-year period. Adjusted diluted earnings per share decreased to $0.33 per share compared to $0.41 per share in the prior-year period.

Now, let's go through the basic numbers regarding cash. Our days sales outstanding were 66 days for the quarter ended December 31, 2013, which is consistent with the prior quarter, but increased slightly over the prior-year period due largely to the impact of the government shutdown. Net cash provided by operating activities year to date was $292.3 million, compared to $398.9 million in the first nine months of the prior year.

Free cash flow was $280 million year to date, compared to $378.3 million in the prior-year period. Free cash flow in the year-to-date period shows a decline over the prior year due to the government's acceleration of payments during the second quarter of our FY13. This comparative decline is partially offset by a decrease in capital spending, which is primarily related to the reduced capital outlays associated with the leasehold improvements to build out our Washington metro offices for hotelling that we completed last winter.

Given our strong cash position and continuing commitment to deliver value to our investors, we are announcing today, as Ralph noted, a regular cash dividend of $0.10 per share and a special dividend of $1 per share. Both are payable on February 28 to shareholders of record as of February 10.

We have been pleased with the performance of Booz Allen engineering services, formerly the DSES division of ARINC and are keeping an eye on other acquisition opportunities, which we will pursue if and when we identify companies whose capabilities are aligned to our strategy, are reasonably priced, and we believe are a cultural fit.

Finally, on the basic numbers, let's finish up with the specifics on our contract wins. The government shutdown had a notable impact on the pace of contracting awards in the quarter. That is reflected in our total backlog at the end of the third quarter, which was $10.37 billion, compared to $12.68 billion in the prior-year period. Additionally, our funded backlog saw a drop to $2.5 billion, compared to $3.15 billion in the prior-year quarter.

The challenges associated with an uncertain federal budget environment, and the uncertainty that presents for our clients, continued during the third quarter. With the bipartisan Ryan-Murray budget agreement and the subsequent passage of the 2014 Consolidated Appropriations Act, we have seen some incremental positive signs. The passage of the omnibus spending bill provides spending clarity through September that should have a positive impact on the pace of awards. We are hopeful the spirit of compromise will continue with an agreement on the nation's indebtedness.

In our own business, we continue to believe that our ongoing investments in key growth areas such as engineering and technical services, cyber and data analytics are positioning us well to take advantage of a future improvement in the market. And, while our commercial and international businesses remain small, we have been seeing traction and are confident of the foothold we've established and that the investments we are making in these markets will help to expand our portfolio of business over time.

With that context, let's turn to slide 5 to review our guidance. Despite the impact of the October 2013 government shutdown, we are narrowing the range for earnings in line with our previous guidance for FY14, which now calls for diluted earnings per share in the range of $1.50 to $1.54 and adjusted diluted earnings per share in the range of $1.58 to $1.62. In addition, we are projecting a mid-single-digit percentage decline in revenue.

Now, I'll hand the call back to Ralph.

Thank you, Sam. Before we move to the question-and-answer section, I want to share some developments coming out of yesterday's Board of Directors meeting. I've been with Booz Allen for long enough to be a rather learned students of our Firm's history. Our history is a history of people, not of products. The thing that has amazed and impressed me throughout my tenure is how well we hand off the baton, how the next generation of leaders builds on those who came before and takes the Firm ably into the future.

Yesterday, the Board accepted the retirement request of two members of our Executive Management Committee. Our Chief Financial and Administrative Officer, Sam Strickland, and our Vice Chairman, Mike McConnell, will both be retiring on June 30 of 2014. Sam will also step down from his positions as Treasurer and on Booz Allen's Board of Directors upon his retirement as of June 30.

I'm pleased to report that the Board also approved my recommendation for Sam's successor as Booz Allen's Chief Financial Officer. Kevin Cook, who you know as our longtime Controller and Senior Vice President of Finance, who has been on every earnings call since our IPO, will become Booz Allen's CFO and Treasurer on July 1 of this year.

Kevin's impact on Booz Allen's business has been significant, most notably in building our finance organization for a strong public company and in creating the Firm's shared services organization. I've known and worked with Kevin for more than 20 years and have the utmost confidence in him.

To fill Sam's other leadership role, that of Chief Administrative Officer, we have tapped Executive Vice President Joe Mahaffee, who has been with Booz Allen for more than 25 years and is a proven leader in both line and staff positions. I'm pleased to say that Sam will continue to be associated with Booz Allen, as a Senior Executive Advisor after his retirement, giving us the ongoing benefit of his great experience and judgment.

Likewise, Mike McConnell, who is one of the world's leading experts on cyber security, will remain associated with Booz Allen after he retires from a full-time leadership position. Mike will serve as a Senior Executive Advisor to us and participate in external forums on our behalf.

As we announced in December, Booz Allen's Chief Operating Officer, Horacio Rozanski, who is also familiar to all of you from our earnings calls, has assumed the additional role and title of President of the Firm. Horacio has been shaping and driving Booz Allen's long-term strategy, that we call Vision 2020.

I still remain Booz Allen's Chairman and Chief Executive Officer, and am excited about this new chapter in our Firm's history, and look forward to working with Horacio and Kevin in their new roles, as well as the other members of the Firm's strong leadership team. Please join me in thanking Sam and Mike for their tremendous contribution to our clients, people, and investors.

Now, I'll turn the microphone back to Curt for our question-and-answer session.

Thank you, Ralph and Sam. At this time, our President and Chief Operating Officer, Horacio Rozanski; and Senior Vice President and Corporate Controller -- and, as Ralph just announced, our CFO-Elect, Kevin Cook, is here with us to help answer your questions.

Stephanie, can you please provide instructions for the question-and-answer session of the call?

(Operator Instructions)

Carter Copeland, Barclays.

Congratulations to you all on the various new roles and retirements.

Thank you.

I wondered if I could ask two questions. The first is related to the end market outlook. Obviously, we've had challenges this year with the government spending environment.

But as you put together your plan for next fiscal year, can you tell us how you're thinking about when it is that organic revenues may find a bottom given the fact that we now have a budget agreement? We should have a federal budget submitted in regular order. Tell us how you're thinking about that? How it applies to hiring? Just look inside your crystal ball and tell us what that means for the forward look for next year?

Carter, let me jump in here. In terms of our forward look for next year, I think, consistent with our practice last year, we will wait until our annual earnings call, which will be in late May to cover that.

But let me tell you what we're seeing now. Clearly, as a result of the budget agreement and passage of the spending bills for the government FY14, that certainly improves the environment. That said, it's going to take the government and contract community, as a general rule of thumb, is 60 to 90 days to start flowing that down.

So when we look internally, we're starting to see some positive signs. We have not yet started to see dollars flow. Now, we fully expect that -- as you know, there is a high incentive for the government to get that money allocated by September 30. We expect that to happen.

We also believe that we have invested to position ourselves both in terms of market positioning and developing the capabilities required to deliver on that market position. We feel like we've made good choices there. As you know, that's been the hallmark of our success for more than 20 years.

So I think, we are optimistic that between now and September 30 there will be ample awards. To our thinking, we would like to make certain that we see the money start flowing before we start providing our expectations for what will be our FY15.

That's fair. I'm just trying to get a sense of where you think the bottom might be out there. But I can appreciate the fact that visibility is still somewhat limited.

Just one other quick one, on the adjustment to the total backlog in the quarter, you noted that was related to a reduction to two particular contract vehicles. Can you provide some color on what that was?

I'm not sure we understand your question, actually. I think the reduction in the contract backlog is really the result of -- we saw -- while we saw a lot of -- we saw a reasonable number of ID/IQ awards during the quarter, we didn't see a lot of funding behind that.

So I think what you're seeing is that our clients are -- funding is more on a short-term basis. As a result of that, we're seeing a drop in backlog. Importantly -- or more importantly, we're seeing a drop in the period of performance covered by the backlog. So the clients are doing it a bit more short -- are funding it on a shorter period.

Now, I think what you might be talking about when we described -- this is a disclosure that we've had since we went public, we have two large government wide ordering vehicles. There's IAC and SURVIAC, I guess. Although, IAC has got a new name. They're interesting contracts in that clients can allocate money for three years.

We do go through -- based on a long history with those contracts, there is a fairly standard percentage by which the amounts funded or the amounts awarded is actually overstated. I think that's just the nature of the contract. So those are actually two contracts where we take a look at the actual award amounts and discount those for what we expect to be generated by those contracts.

That said, I think, we've checked and our adjustments for the third quarter have not varied significantly from prior quarters.

Okay. Thank you very much, gentlemen.

Carter, it's Kevin. I just wanted to add that we've won a number of contract vehicles this year. They're multi-award. We're basically waiting for the funding to come through on those. We would hope to see that between now and the end of September.

However, the backlog -- the way we calculate it is fairly conservative in that we don't anticipate any ID/IQ revenue in our backlog until we've actually been awarded the task orders. This is a little bit more conservative than some other folks, but we think it's probably the best approach for our investors.

Okay. Thank you, Kevin.

Bill Loomis, Stifel.

Sam, after working with you for 20 years, congratulations on a well-deserved retirement.

Thank you, Bill. I'm looking forward to it.

Kevin, congratulations to you. It sounded like Curt didn't believe you were CFO for a little bit.

(laughter) Certainly shocked. Getting used to it.

Just looking at organic growth though, I know you talked about the material pass-through's being down with little margin attached to that. It helps explain some of the organic growth drop, but consulting headcount was down 8% year-over-year. That's a number that we've seen that's been fairly consistent with some of the others. Historically, Booz has been a market share gainer.

What's going on? Why isn't that down 3%? Is it subs from the programs that you're targeting? Or some of the investments that are going to pay off down the road?

Bill, it's Horacio. Let me try and take a cut at that. I think over the last year, we have -- we're reorganizing the beginning of fiscal year. We have been running the business much more efficiently. So the number of billable hours per staff is way up -- or billability therefore is way up.

So we've been able to really get more -- much more performance out of our existing staff base. So we actually have been able to fund all of our investment programs which are running at about the same rate as in prior years even with a reduced headcount.

So there's more of a story of efficiency there than there is of a pulling back or anything else. We remain, I think, committed to doing better than the market. Now, as you can tell, the market is not great, at least at the moment. So doing better than market is still not as well as we would like to do, but certainly we are leaning forward and looking for opportunities to grow, as Sam said earlier, both organically and inorganically.

So it sounds like -- that helps explain some of the margin improvements as well from what you just said. Just to follow on with what Carter was talking about, in -- the book-to-bill you had was zero or slightly negative because you had some write-downs on backlog on those two task orders.

Was it IAC and SURVIAC? Were those the two vehicles that you mentioned in the press release that you had task order value write-downs? Again, what changed there specifically to take those out of backlog?

Yes. Those are the two that we referred to, but, Bill, if you look back, we've done that every quarter. Again, it's the nature of those contracts where clients like to put money on those contracts and then they can reprogram that money. The contract vehicle allows for that.

So when we took a look at the historical funding and let's call it, burns on those contracts -- revenue burns on those contracts, we decided that we needed to discount that. The discount is not much. It's been a couple years, but it's somewhere in the neighborhood of 7% to 10%. Something minor like that.

But there wasn't a major adjustment this quarter associated with that. Those adjustments have been in every quarter.

Okay. Thank you.

Robert Spingarn, Credit Suisse.

I'll echo the congratulations to everybody.

Thank you.

I wanted to -- two questions, really, one on revenues and bookings and the other on margins, this follows up on what Carter was talking about with regard to the deal and the improved visibility. Since we have a two year deal here, should we not have the kind of disruption that we would normally have or that we've had for several years in a row in the fall period? As you go through and essentially, once you get visibility, is it for a longer period this time?

I think that's a safe assumption, Rob. That's certainly what we're counting on. So again, we haven't started to see the flow of awards and the flow of funding at this point. We're witnessing the government gather its forces to get ready to do that.

Because, as you know, there's a strong incentive to get that done by September 30. But we're anticipating with, let's call it, a two year run that it should be a much more stable environment for us going forward.

Right. Then on the margin side -- you touched on this last quarter and a little bit today, could you perhaps give us a little bit more granularity on the relative decrease in profits and earnings against the relative decrease in revenues? Then how the margin profile should evolve from here sequentially going forward over the next few quarters? Just given the big differences that we're seeing?

I think if you take a look, we had a choice to make when we had a 16 day government shutdown. That choice was to layoff our staff or to carry those staff. As a result of that, we of course decided that it's Booz Allen's way that we would carry those staff.

That's $30 million reduction in revenue without a corresponding decrease in expenses. So that's certainly hurt the quarter. I don't expect the margins for this quarter to be reflective of, let's call it, annual margins going forward.

The other thing I'll point out is consistent with that, as we announced at the end of the second quarter, we were going to build -- we were going to invest in building capability in the back half of the year. In fact, we have been doing that. If you look at just the way the accounting works on the cost-plus and then the T&M and FFP contracts of course when you're spending below your, let's call it, your average approved indirect rates, when you're spending below that, you tend to get -- you show more profitability on your T&M and FFP contracts. Now, you want to make certain that by the end of the year you're in line with your rates. Right?

So what you're seeing now, we were very conservative in the first half to make sure that we were well-positioned for whatever happened in the back half of the year. Now we feel like we have a handle on it, we're trying to make certain that we're well-positioned going into our FY15. Also making sure that we're spending consistent with the annual rates that -- inherent in our contract backlog pricing. I don't want to --

No, go ahead, Sam.

I was going to say, I didn't want to get too technical in the vagaries of government contracts accounting. But that's the dynamic. That's the trap we fall into with this quarterly reporting -- reporting on a quarterly basis and managing on an annual basis.

Well, so, that's kind of what I was after. Because when you have, again -- you pass-through all this -- the revenue really passes straight through to costs, given that you kept people on. But you've also had some of this infrastructure type change. So how do we think about forward margin? Is it an 8% type margin as we go forward, when you've gotten past all of these puts and takes?

Well, I think that it's an interesting question. The way I would look at it, is if you eliminate the effects of the government shutdown, then I think where we're going to end up in the year is likely what we'll be looking at for future years.

In other words, we don't -- when all the accounting is done for the fiscal year -- of course, we manage this on a fiscal year basis. I think that's the margin you're going to get, except for the government shutdown. Of course, we've looked to improve that modestly going forward.

Rob, it's Kevin. Through the nine month period, we're up 110 basis points at the adjusted EBITDA line. We would -- if you go back to the IPO, we've always talked about 10 basis point improvement year-over-year.

Right.

Clearly, we're in good position to deliver on that this year. Going forward, I think contract mix will play a big part. How much our commercial and International grows, which will really drive significantly higher margins. So there's a lot of variables that go into it.

Okay. Thanks very much.

Brian Gesuale, Raymond James.

Congratulations to all of you.

Thank you.

I wanted to maybe shift gears a little bit and hit on something, Kevin, that you just touched on. Can you give us an update on the commercial and cyber business? Obviously, it's been in the news particularly in the retail channel.

I know that wasn't an initial industry focus for you guys, but could you maybe just talk about the tempo in that business? Give us an update, please?

Sure will. We are feeling that we're gaining traction in both our commercial and International space. We've talked on this call previously about not wanting to talk in depth about it until it gets of size, but we do feel that relationships that we've been investing in over the last two or three years are beginning to pay off.

You'll hear comments from the commercial market that they're looking for firms that can deliver military grade cyber in the commercial world. We're one of the few firms that can do that. I think as the cyber scenario unfolds going forward, we're well-positioned to help commercial and International clients prepare and then weather the storm if they are attacked.

Okay. Great. Then just wanted -- you guys have always done a very good job on tactical selling and are very close to your clients. Can you talk maybe a little bit -- you started in the initial question talking about clients feeling a little bit more optimistic. Can you put some color around what a bookings cadence could look like if you expect backlog when it begins to grow?

Maybe talk about some of the headcount numbers? I know you don't hire in advance of business and sit people on the bench. But when some of those key business indicators for you might turn positive?

I can give you a bit of a -- it's Horacio -- a bit of a historical look plus guesstimate. (laughter) If you take it with many grains of salt, I think you'd be well-served. (laughter)

Historically, what you see is that after the passing of a continuing resolution, it takes about 90 days for the funding to actually become available to clients. Because it's got to go through. B, it's got to get a portion. It's got to get sanctioned. It's got to move down.

So I think the expression Sam used is the government is marshaling its forces to go after this. I think that's the general sense, is there's an expectation that this will move through in that level of orderly fashion.

The other dynamic that we've seen is that more and more gets pushed into the summer. That the heavy-duty selling season begins later and later in the summer and creates a bigger spike into September. It's not the way we would like to see it. It's probably not the ideal way for the government to do it. But it's the way that they do it given the way the entirety of their challenge.

So that's, in general terms, what we are expecting is, it will take 90 days for things to begin to drive forward. The bigger question for us and the place where we place some cautious optimism is on the fact that uncertainty is the killer here. At some point, you would like to think that the key government personnel will start to feel a little bit more certain about at least their 18 month outlook and begin to act that way. But that's going to take time.

They've been shell-shocked by what's happened over the last few years. We've seen contracting shops, even now, behave very cautiously even though they know the money is at OMB, even though the money is coming and so forth. They are saying I can't -- until I have it, I'm not willing to act because I've been burned in the past. So it's going to take a little bit of time for the key government people to get to the place that they can act with more certainty and more confidence.

Great. Thanks very much, guys.

Tim McHugh, William Blair & Company.

Just want to ask about some of the sectors within the business. I know you talked last quarter, I think, about intelligence starting to see some weakness or catching up to the other areas. I guess, just commercial -- civil versus defense, any color on the trends? If they varied at all?

I think we've seen a continuation of the trends we saw earlier. If you look across the board, the decline in civil, which by the way, includes the Veterans Administration, DHS, so forth, is down the least, followed by defense, followed by security.

So if you're looking across that -- we try and talk about that on an annual basis because, again, that's the way we manage the business. So, we don't see that changing in the near term, but let's see how the money starts to flow when the weather gets warmer, which I think we all hope it does.

Okay. Then you talked -- it sounds like you're a little more interested in acquisitions now at this point -- I guess you've digested the engineering group. I guess, is that an area you'd look to continuing to invest in? Or are there any particular areas that stand out right now that would be good fits for acquisitions for you guys?

I think the answer is, we have been interested in acquisitions. We've had a fairly robust screening activity. Our focus going forward I think is we've identified three areas, one of which is, let's call it, system development -- software engineering systems development, again, we'd be interested in more engineering capability. We, in rough terms, doubled our capability when we bought DSES. Then third area which we take a look at is around the data analytics.

Now that said, we also look at other things that come available on the market. If we saw something that was outside of those three areas -- but again, we felt like brought real upside and was still consistent with our strategic thrust, then we would do that as well. So we're looking. I think we have been looking since even before the DSES.

I have to say, Tim, what we're -- honestly, what we're not looking at is small things. If that makes sense to you. Under the theory, that we're looking to use our time and energies on something that's going to make a difference.

Okay. One last question, obviously, given the environment, you've had to manage the headcount down quite a bit. But I imagine it's not easy on the organization when headcount's -- consulting headcount's down 8%.

So what's the morale around that? Is that having an impact on turnover levels? Or any other metric you could use to judge that within the consultant base at this point?

It's a great question. The last couple of years have not been fun on the industry. I think -- it's a lot more fun when we were growing at 20%, that's for sure. Having said that, I think what we've focused on internally is the fact that we actually run this business for the long-term. That we invest in our future. That we invest in our people.

We recently launched a new people model that takes full advantage of all of the different roles that people play at Booz Allen and fosters the development of more technical capabilities. We've made significant investments in the launch of -- or relaunch of our functional communities. Certainly the way we behaved during the shutdown as compared to the way almost everybody else chose to do it, continues to create a sense internally that we really are running this business for the long-term. That we care about our people. That we care about our clients.

In that combination, I would say that moral right now is about as good as it can be given the overall environmental circumstances. Frankly, probably better than it's been in a while.

Okay. Thank you.

Edward Caso, Wells Fargo Securities.

Congrats on managing well through a difficult period here. I was hoping you could talk a little bit about your support of the intelligence community, both the three letters plus the defense part of it. If you could remind us, what percent roughly of revenue that is?

Maybe what pockets generically speaking are strong and what are not? Because we've been picking up fairly mixed signals of late as far as spend pace and so forth out of the intel community. Thank you.

Well Ed, as you know, we're -- particularly given the way we operate the Firm, we try not to get into segment reporting. So I will tell you that historically and continuing the intel business is something like the mid 20%. That fluctuates around depending upon ODC levels and so forth.

So that's -- particularly when it gets down to talking about individual agencies, that's something we've not done. I'm sure that something that our clients would prefer we not do.

I guess, my question is really around types of services. Presumably, cyber is strong. Are other areas weak? Is that what you're seeing? I'm not looking for agency by agency.

In terms of the type of services? Again, it's always difficult for us to quantify each type of service, simply because our contracts allow us to provide a variety of services -- the variety of services that we have. So I don't -- we haven't seen a particular change in the mix so far.

Okay. My other question is on the pace of payments from the contracting offices. One of your competitors mentioned that they're being instructed now to pay on terms. They had previously been paying before the required limit. Are you seeing that slowing pace of money coming out the contracting offices?

Ed, it's Kevin. It is a little slower. I think it's a combination of the shutdown and the payment offices are struggling to get back on track.

Then there is, as you recall about a year ago, the government issued an edict that the agencies were supposed to pay small businesses in net 15 instead of net 30. They actually started paying everybody net 15, assuming that we would then turn around and pay our small business subs quicker as well.

They have -- they did back off of that for a bit. I hear that they may be going back to that. But that has contributed a bit to a slowdown.

Great. All the best, Sam, in retirement.

Thank you. I'm looking forward to it Ed. I've enjoyed working with you.

Suzi Stein, Morgan Stanley.

Can you just touch on the book-to-bill number? Is this just a timing issue? Should this return to a more normal level over the next quarter or two?

Well, certainly our hope is that -- traditionally, the third quarter -- again, that the government the funding builds to a crescendo as of the September 30 quarter. So this quarter, the December quarter, is traditionally the lightest of the four.

Then the March quarter will be a little better. The June quarter will be a little better. Again, we're back to September quarter is when the mother lode comes through. We fully expect that pattern to continue this year.

Clearly, the December quarter, if you think about the shutdown and even the DOD which declared a lot of folks as critical and therefore kept them working during the shutdown, I think an awful lot of the procurement and finance personnel were in fact furloughed. So they kind of went through a -- not exactly a full stop. But there was a pretty good lull there.

So now they're getting back into it. If you think about the year -- so you had a shutdown. You came out of that. You went into the Thanksgiving holiday.

As you came back from that, you went into the end of December winter holidays. So those are all things that tend to slow stuff down. So actually, I was pretty pleased that we got back to 66 days as of December 31. That was -- it's actually rebounding a little faster than I thought it was.

Again generally, our low point for receivables is March 31. So we're optimistic we can get there in terms of our cash. But in terms of contracts awards, again we would expect that to follow our historical pattern of -- the January quarter being better than the December quarter. Then the June being better than that. Then the big quarter being the September quarter.

Okay. Great. Thank you.

Jason Gursky, Citi.

The midpoint of your EPS guidance heading into the fourth quarter here is about $0.30. I wanted to give you an opportunity to perhaps address why it would be a bad idea to annualize that number as we move into the next fiscal year? You talk a little about the things that are under your specific control that will allow the $0.30 number not to be what we would see as we move into FY15.

As we've said, we do manage it on a quarterly basis. So we're managing our spend plans on a quarterly basis. We generally tend to be conservative in the first half to make sure that our topline -- as you know, this business is an easy business when you think in terms of, like any business, you have to manage your cost in relation to your revenue. Right?

So while we have to report on a quarterly basis, we will manage both our spend plans and our investments on an annual basis. So I think that's why, if you take a look at our annual guidance, then -- which we've put out, that gives you a pretty good indication of what we expect to do for the year.

I think that's the number then you need to take a look at for the following year, as opposed to taking one quarter. Because one quarter can be -- let's call it, distorted by things like shutdowns or things like snowstorms.

We had an interesting situation here within the Washington area, where we have a significant amount of our business where we were closed for about two days. So we'll work hard to recover on that. But one of the reasons we've never provided quarterly guidance is that we don't want to get into the trap of having to manage on a quarterly basis. Because it just doesn't make sense in our business. So I think the annual number is what you want to focus on.

Jason, it's Kevin. I've got to admit, I'm sitting here with a smile on my face, because at the end of our second quarter, we cautioned everybody not to take our first half results and multiply by two, because we were going to invest in the second half. We had the government shutdown.

Now we kind of have the opposite question, where you're saying, well, the $0.30 in the fourth quarter, should we extend that for the year? Sam pointed out, we manage annually. We've been very consistent in hitting our bottom line guidance for the last, I guess, since we've gone public, frankly. So we always encourage people to look at our guidance and use that as a basis for the following year.

No. Fair enough. I just wanted to make sure that wasn't necessarily the right way to be thinking about it. That you do have the same types of flexibility this year that you had -- flexibility going into the next year that you had this year. What you're trying to say is that you do.

Right.

Exactly.

Okay. Then just a quick follow-up, have there been any significant mix change in your contracts? They were running well above the 10 basis point EBITDA margin expansion that you've talked about wanting to hit on a year-to-date basis thus far. Is there any notable change in mix of contracts that's allowing for that? Is that going to be sustainable?

Jason, it's Kevin. We've had a very consistent contract mix over the last couple years. You'll see in some of the non-GAAP measures we provided I think on Schedule 5 or 6 of the earnings release where our fixed price percentage of revenue went up slightly in the third quarter. Part of that's attributable -- most of that's attributable to a contract in our Booz Allen engineering services group that converted from a combination of cost-plus and T&M over to fixed price.

So other than that, it's been very consistent over time. Based on the type of work we do, we feel pretty confident that mix is going to remain somewhat stable. There is, I think, a desire by the government to move away from T&M into cost-plus. We've been over 50% cost-plus for as long as I can remember.

So we're used to working in that and managing in that environment as opposed to other companies that are seeing their margins get pressured by the move away from T&M.

Okay. That's helpful. Thank you very much.

Cai von Rumohr, Cowen.

So I guess I have two. One, we've seen the low price technically acceptable in some of your competitors, indicating that maybe we're about to see the pendulum switch the other way. Have you seen any evidence of that?

Well, I think we certainly heard enough talking about that from our clients side, that they're starting to recognize the pitfalls and starting to recognize just how much that disrupts, let's call it, mission delivery when you go to that. So have we started to see -- the key is more not what they say but what they do, right?

So even when they put out best value proposals, in the past, they've had a tendency to drive it towards low-cost technically acceptable. So we're seeing clients talk about it. We're seeing clients start to address it.

So I think we're optimistic that situation is going to improve over the next, let's call it, the next 12 months.

Then the last question is the recovery from our current situation. In one sense, we've seen a perfect storm where you had a request for FY14 that looked unrealistic and looks like we're going to go into sequester. We have the government shutdown.

All of these things really dampening down the near-term. Now, we have a FY14 appropriation. To your point, they have to spend the money by the end of the year.

So that while it's very difficult to say when we get the snap back, is it your opinion that we have the potential for kind of an overshoot snap back, just because they have to appropriate -- the have to commit the money?

(laughter) I have to tell you I'm not sure I can define an overshoot snap back. I understand what you're saying, but we'd have to put that in our non-GAAP measures I believe. (laughter)

No. Look, let's see -- I think we are going to be interested to see how quickly they get up and running on this. As Horacio mentioned early on, the tendency has been to get more and more into that September quarter. So we're hopeful, of course, that they'll get more and more into the earlier quarters. But we'll just have to see how that rolls out.

Thank you very much.

Sure.

Thank you. I will now turn the call back over to Ralph Shrader for closing remarks.

Thank you. Well, I hope we've been able to show that our effective management of Booz Allen's business has kept us on track to deliver our earnings commitment for FY14. We were able to weather the government shutdown, while continuing to deliver solid bottom line performance through nine months. We continue to generate strong cash flow.

We're cautiously optimistic that the recent budget agreement on Capitol Hill will reduce uncertainty for our clients and improve the business climate going forward. As we described this morning, we continue to invest in the future of Booz Allen's business and are excited about the road ahead, while we celebrate our past in a special way during this very important centennial year.

I want to thank you all for joining us this morning. Wish you a good day. Bye, now.

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect. Have a wonderful day.